Question

Casey Hyunh is trying to value the stock of Resources Limited. To easily see how a change in one or more of her assumptions affects the estimated value of the stock, she is using a spreadsheet model. The model has projections for the next four years based on the following assumptions. • Sales will be $300 million in Year 1. • Sales will grow at 15 percent in Year 2 and 5 percent in Years 3 and 4. • Operating profits (EBIT) will be 17 percent of sales in each year. • Interest expense will be $10 million per year. • Income tax rate is 30 percent. • Earnings retention ratio would stay at 0.60. • The per-share dividend growth rate will be constant from Year 4 forward, and this final growth rate will be 200 basis points less than the growth rate from Year 3 to Year 4. The company has 10 million shares outstanding. Hyunh has estimated the required return on Resources’ stock to be 13 percent. A. Estimate the value of the stock at the end of Year 4 based on the above assumptions. B. Estimate the current value of the stock using the above assumptions. C. hyunh is wondering how a change in the projected sales growth rate would affect the estimated value. Estimate the current value of the stock if the sales growth rate in Year 3 is 10 percent instead of 5 percent.

Answer 1

1-
Year	1	2	3	4		5
sales =sales in year 1*(1+growth rate)	300	345	362.25	380.3625
EBIT-17% of sales	45	51.75	54.3375	57.05438
less interest	10	10	10	10
EBT	35	41.75	44.3375	47.05438
less tax-30%	10.5	12.525	13.30125	14.11631
net income	24.5	29.225	31.03625	32.93806
Expected dividend-40% of net income	9.8	11.69	12.4145	13.17523	13.175*1.02	13.4385
terminal value of equity in year 4	expected dividend in year 5/(required rate of return-growth rate)	13.44/(13%-2%)	122.12
value of stock at the end of year 4	terminal value of equity/no. of stock outstanding	122.12/10	12.21
2-
Value of stock-Today
Year	1	2	3	4	4
cash flow	9.8	11.69	12.4145	13.17523	122.12
present value factor at 13% =1/(1+r)^n r=13%	0.884956	0.783147	0.69305	0.613319	0.613319
present value of cash flow = cash flow*present value factor	8.672566	9.154985	8.603871	8.080612	74.8974
value of equity =sum of present value of cash flow	109.41
value of stock per share-Today	value of equity today/no.of stok outstanding	109.41/10	10.94
3-
If sales growth rate is 10% in year 3
Year	1	2	3	4		5
sales =sales in year 1*(1+growth rate)	300	345	379.5	398.475
EBIT-17% of sales	45	51.75	56.925	59.77125
less interest	10	10	10	10
EBT	35	41.75	46.925	49.77125
less tax-30%	10.5	12.525	14.0775	14.93138
net income	24.5	29.225	32.8475	34.83988
Expected dividend-40% of net income	9.8	11.69	13.139	13.93595	13.9359*1.02	14.21462
terminal value of equity in year 4	expected dividend in year 5/(required rate of return-growth rate)	14.2146/(13%-2%)	129.22
Value of stock-Today
Year	1	2	3	4	4
cash flow	9.8	11.69	13.139	13.93595	129.22
present value factor at 13% =1/(1+r)^n r=13%	0.884956	0.783147	0.69305	0.613319	0.613319
present value of cash flow = cash flow*present value factor	8.672566	9.154985	9.105986	8.547179	79.25531
value of equity =sum of present value of cash flow	114.74
value of stock per share-Today	value of equity today/no.of stok outstanding	114.74/10	11.47